Friday, January 7, 2011

The bond market is watching Illinois carefully

One of the interesting stories we will see play out this year is what will happen in states that are heavily indebted and have made little to no progress toward balancing their budgets.  Exhibit A in today's WSJ is Illinois, which has issued debt to pay current operating expenses (always with a promise to come up with a better solution next year, and the year after, and the year after that).  Illinois 10-year bonds are priced a full two percentage points above the broader state-local bond market. 

What's a bond buyer to do?  The two extra points look attractive, but maybe the spread will widen.  If the state does not get its budget in order, what is the default risk?  Would Bernanke and Geithner swoop in and save Illinois with federal dollars?  The state is considering raising its personal income tax from 3 to 5.25% as part of its budget deliberations. 

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